Is the dollar's decline over? Dollar
Published: May 25 2005 13:30 | Last updated: May 25 2005 19:43
Is the dollar's decline over? The Federal Reserve's nominal broad trade-weighted dollar index fell by 17 per cent between its peak in early 2002 and the end of 2004. So far this year, the index has risen by 3 per cent. The headline advance, however, masks a shift in relative performance against major and emerging market currencies.
The greenback has rallied against major currencies, which had borne the brunt of its decline. But, while China has yet to revalue the renminbi, emerging market currencies have started to absorb dollar adjustment. The Korean won and Mexican peso both gained ground, while the Brazilian real has appreciated by 12 per cent since the start of the year.
Theoretical exchange rate models confirm the need for dollar weakness to rotate towards emerging markets. Goldman Sachs estimates that, overall, the dollar is trading close to its long-term equilibrium on a trade-weighted basis. But it is undervalued by about 5 per cent against major currencies, while 10 per cent overvalued against emerging market currencies.
In the short term, dollar strength against the majors may persist. But, even if Goldman's estimate is correct, this does not remove the need for dollar depreciation. A period of significant undervaluation is required to help cut the US current account imbalance. The trend for emerging markets to share more of the burden, however, has further to run. Patient renminbi speculators will eventually gain their reward.
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